One of the most iconic names of the Internet era is eBay (EBAY). Some overall statistics about the stock include:
- Revenues of $11.7b
- Earnings of $3.2b
- P/E ratio of 13.3
- P/B ratio of 2.3
These are very solid overall fundamental numbers, but before considering an investment in eBay it is important to remember that eBay now has two main businesses:
- Marketplaces: This segment of the business contains the flagship auction/retail site that many people use to buy and sell merchandise. They also own several other web sites such as stubhub.com, shopping.com. etc. Marketplaces account for slightly more the half of the companies revenues and profits.
- Payments: This segment of the business primarily consists of PayPal. Paypal is heavily used as a payment mechanism on ebay's marketplace sites. However, it is also increasingly used through out the world of ecommerce.
These business do interact and provide some synergy, but they are also very different. One is basically retail oriented, and the other a financial services business. They have different business drivers, metrics and competitors.
From an investment perspective, having two businesses under one roof can both be good and bad. This provides diversification, which means less risk to an investor. It also tends to provide a floor under the price of a stock. Conversely, having two businesses makes it hard for the stock to move up quickly based on any one big driver. This struggle between the good and bad of having two businesses under one roof can be seen in the performance of the stock over the past year. The stock has oscillated in the range of $27 and $35. There does not appear to be an obvious short term catalyst to drive the stock out of this range.
If an investor believes the stock will stay in that range, one suggested way to profit is to sell a strangle. That would involve selling an out of the money put and selling an out of the money call to generate a credit and then hoping for the stock to stay within that trading range. For example, as of the time I'm writing this article, the stock was trading at $32.80 and the April $28 -$35 strangle was selling for a little over $1. A few scenarios and their probabilities are shown below:
- According to the option theory there is a 78% chance the options will expire with the stock trading in this range. For the reasons stated above, I think the probability of the stock trading sideways is greater than this pure mathematical formula. It is not clear what catalyst can knock the stock out of this range. In any event, there is almost an 80% chance of making 3% on this trade. Not a home run, but in today's low rate environment this represents a decent two month return without taking on too much risk.
- On the downside, this trade does not lose money unless the stock falls to $27 at expiration. (The $28 strike less the $1 credit). That would be about an 18% drop from the current price. In theory, there is only a 4% chance of the stock dropping that far. It is hard to envision what will have happened to drive the stock down 18%, but I'm willing to take the risk of owning the stock at this level.
- On the upside, this trade starts to lose money if eBay breaks out of its trading range and trades at $36 at expiration. (The $35 strike plus $1 credit). The theoretical probability of the stock being 10% higher at expiration is about 18%. This situation is worrisome because the risk related to being short this call is theoretically unlimited. Since I think the market is somewhat overbought, and eBay is trading at the top of its range, I'm willing to take that risk. However, it might be prudent to spread off this end of the trade by buying a higher priced call. Perhaps by buying the $38 call for about $.15. This will reduce the profit potential for the most probable case above, but will define the risk on the up-side of the trade.
In summary, eBay is a unique company with two diverse businesses. That potentially makes it both a less risky investment, but may also limit its upside. If an investor feels their is no catalyst to drive this stock out of its trading range the option trade above might be worth considering.
Disclosure: I am short EBAY.
Additional disclosure: This posting is for informational, educational and entertainment purposes only and should not be considered investment advice.
